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Default Risk and the Effects of Fiscal Policy on Interest Rates: 1929–1945

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  • David Bowles

    (Southern Bell)

  • Holley Ulbrich
  • Myles Wallace

Abstract

Conventional macroeconomic models suggest that expansionary fiscal policy causes higher interest rates, resulting in crowding out of private investment. In this article, we argue that such models ignore the default risk differential between the interest rates on government bonds and corporate bonds. If expansionary fiscal policy causes an expansion in real GNP, default risk falls on corporate bonds. Our model suggests that if the default risk premium falls, (1) corporate interest rates may fall relative to rates on government bonds and (2) private investment is crowded in. We find some supporting empirical evidence of this effect for the period 1929–1945.

Suggested Citation

  • David Bowles & Holley Ulbrich & Myles Wallace, 1988. "Default Risk and the Effects of Fiscal Policy on Interest Rates: 1929–1945," Public Finance Review, , vol. 16(3), pages 357-373, July.
    • Handle: RePEc:sae:pubfin:v:16:y:1988:i:3:p:357-373
    DOI: 10.1177/109114218801600307
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    References listed on IDEAS

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